Business As Unusual: Partner, share and trust in order to extend capabilities
The business cycle teases out the good or lucky from the exceptional. Highly adaptive companies, whose primary core competency includes agility itself, are most prepared for times such as those we experience today. These companies demonstrate the tenets listed below, and here we will discuss the second of those:
Core tenets of companies most able to adapt to business cycle and disruption:
Become and remain low cost, transparent and consistent
Partner, share and trust in order to extend capabilities
Abstract core capabilities into new markets or channels
Creatively exploit less agile incumbents’ weaknesses
Continuous joint planning and collaboration are defining characteristics for enduring companies, successful business partnerships and paradigm shifters. The “mutualization” of the value chain demystifies the planning process, ensures collective trust and a growth mindset for all involved. When opportunities or threats emerge, collaborators are most capable of objective analysis and embracing creative solutions rather than engaging in zero sum battles for a piece of a “finite” pie.
Below are two historical examples from US physical retail and European stock exchanges. In your industry’s value chain, you should find ways to emulate the protagonists below. Or if your company currently sits from a position of strength, this may raise awareness of how others may seek to lift you off your comfortable perch if you don’t innovate with them.
Example: Retail / Walmart
While hard to imagine, only 30 years ago K-Mart was the US’s largest discount big box retailer, operating brands including Walden Book Company, Builders Square, the Borders bookstore chain and the Sports Authority. Since that time, Walmart has rapidly emerged to the largest ever firm in the physical retailing world, but it is no accident nor coincidence. It is by design, and accomplished through discipline. K-Mart (and Sears, it’s current owner) have failed epically where Walmart excels, serving as America’s hometown store with maniacal efficiency.
If you want to sell your products through Walmart, you are going to learn how to design and fulfill at low cost and when expected. Suppliers who learn to serve Walmart are able to serve anyone. They will have improved, if not best-in-class processes as a result. It’s boot camp for suppliers and Walmart is the drill instructor.
Walmart is firm, but fair to deal with. If you want to serve Walmart effectively, you become part of it. Bentonville, Arkansas, Walmart’s hometown, is also home to teams from suppliers who, while working for their own companies, are fully embedded at their customer. Together, teams from Walmart and suppliers engage in continuous joint business planning. To fuel this collaborative process Walmart equips its partners with real-time data via APIs. Not unlike the military in its discipline, universal situational awareness enables Walmart and suppliers to craft holistically for product features, marketing, pricing, logistics, and replenishment. The see and analyze the same thing, and move together to hit the target.
The process is demanding, even grueling, and beneficial for all involved. Walmart competes for customers in one dimension, having limited selection of what you want at the guaranteed lowest price. In crises, customers remember this simple promise. Walmart fulfills this promise by demanding operational excellence from itself and partner suppliers. For suppliers, Walmart provides best-in-class management information and access to the world’s largest physical distribution channel. Dialed-in and streamlined product selection and fulfillment allows this relationship to be profitable.
Researchers at Northwestern’s Kellogg School of Management estimate that suppliers to Walmart are 18% more profitable than otherwise. Why?
The highly-tuned low cost retailer (Walmart) trains its supplier partners to become is resilient and agile
These same suppliers benefit in other channels, where they may sell more differentiated products and services with greater pricing power and margin
This is a differentiator in business ecosystems, and separates historically anchored incumbents from more nimble competitors. The more open and agile constantly incorporate new capabilities around their core, and in doing so improves “the game” of everyone willing and capable of being involved.
Example: European Equities Trading and Clearing / Chi-X Europe and EMCF
Like many low cost providers, Walmart used continuous improvement to dethrone its rivals; subtly different are industries catalyzed by new technology capabilities, regulatory change, or exogenous shocks such as the current pandemic or supply chain breakdowns. When such disruptions occur, industry participants agitate for change that is often difficult for incumbents to deliver, whether due to inability or unwillingness to kill a cash cow. A reasonable and pragmatic reaction to unresponsive providers is cross-industry collaboration. Such efforts aim to realign ecosystems by displacing the antiquated obstructors in their value chains.
This was true in the European capital markets where in 2007, the Markets in Financial Instruments Directive (MiFID) first introduced competition in the trading and clearing of stocks. Before MiFID, stocks traded on the national exchanges where they were listed. These monopoly exchanges, and the clearing houses associated with them, enjoyed freedom from competitive innovation, pricing pressure, and adequate levels of accountability. The new regulation encouraged streamlined, purpose-built platforms to take on national monopolies across the (then) 28 member states.
Along came Instinet, a pioneer in global electronic trading, who launched Chi-X as an alternative trading platform to the national exchanges, a so-called Multilateral Trading Facility (“MTF”), the US-equivalent of an Alternative Trading System (or “ATS”). Instinet provided the vision, technical platform, team, and early funding. Chi-X recognized that they alone would not be able to transform this ecosystem of national monopolies with unnaturally concentrated liquidity. They needed some help from those already in the ecosystem, who themselves would be frustrated with their experiences. They had to figure out how to re-engineer the entire trading lifecycle along with their customers and downstream post-trade clearing partners. They would also need liquidity in the form of banks bringing their trades to Chi-X, and liquidity providers to make markets as buyer and seller.
The trade lifecycle
In order to pique the interest of the trading community, Chi-X not only offered lower transaction fees than the incumbents, they incentivized participation by giving equity to participants based upon the trading volume they brought to the platform. This brought instant alignment of the community.
At the same time, Chi-X worked with Fortis (now ABN Amro) to create the European Multilateral Clearing Facility (“EMCF”), a Dutch clearing house central counterparty (“CCP”). Until then, CCPs were almost exclusively aligned to national exchanges and often shared ownership with the exchanges. Those national CCPs would be slow, if at all willing to serve a competitor to their national exchanges. Coordinating CCPs at each national level would be a long, Quixotic road.
A pan-European solution was needed but didn’t exist. Repurposing its own pan-European capabilities as a clearing firm, Fortis’ EMCF was able to move into the clearing CCP space with relative ease and, at the same time, offer pricing that was dramatically lower and more simplified than the fragmented national monopolies.
As an industry-wide effort to reform and consolidate a broken set of fragmented monopolies, Chi-X (Instinet), trading and clearing participants (banks, proprietary trading firms), and EMCF (Fortis) were integral to each others’ success. Each solved their part of a reimagined trade lifecycle. Collectively they consolidated the ability to exchange shares from most EU countries onto a single trading venue and to novate those trades to a single clearinghouse. The result was an 80-90% reduction in trading and clearing costs, the streamlining of front-to-back workflow, and the complete transformation of Europe’s equities trading and clearing landscape. National exchanges and CCPs had to respond, both in platform performance and more competitive pricing.
13 years later, 35-40% of on-venue trading occurs away from the national exchange, and all CCPs have access to all European trading venues.
EXECUTION AND CLEARING COSTS UK-LISTED STOCKS (2007 VS TODAY)
London Stock Exchange vs. the Lower Cost Alternatives
Leading up to and at the time of MiFID’s 2007 implementation, Mark Spanbroek, then European MD of liquidity provider GETCO worked with the founders of Chi-X and EMCF to re-architect the fragmented and out-of-date trading landscape. Customers such as Spanbroek’s GETCO would lobby their clearing firms (such as Fortis) and trading broker partners (such as Instinet) to repurpose their technology and processes, and work together to support breakthrough solutions with the introduction of a new regulatory regime:
I recall 2005, making the rounds to find a different way of clearing by a non-incumbent CCP in order to launch CHI-X. Only with a new CCP model CHI-X had potential. Fortis in those days understood the need and came up with the business plan and launched EMCF. EMCF was crucial for the success of CHI-X and later BATS in the EU. Coincidentally CHI-X and MiFID were both launched in 2007, within weeks from each other. The first signs that MiFID did its work on competition and in opening up new platforms. Why was EMCF successful? Opening up an independent CCP, clearing and settlement in the cash equity markets costs came down by about 90%. This in combination with the launch of a new platform attracted volume to shift away from the incumbent exchanges.
- Mark Spanbroek, then European MD of GETCO, the largest liquidity provider at the time and a launch customer of both Chi-X and EMCF
Chi-X’s CEO at the time, Tony MacKay, echoed Spanbroek’s praise for the front-to-back solution delivered collectively by the industry, including re-purposing old technology for new uses to deliver on behalf of customers.
...one of the issues not appreciated was that EMCF was a market solution rather than a technology solution. Fortis repurposed old IBM mainframes to deliver modern markets that met the traders' needs… You and your team (Fortis/EMCF) enabled European Clearing services to modernise in a way that would never had happened without competition. I also believe that Chi-X Europe would not have been the success that it was without EMCF. It was a classic case of listening to customers and delivering a better product - cheaper, faster and smarter!
-Tony Mackay, Chi-X’s founder and president of Instinet at the time of Chi-X’s launch
The vision of companies working together with the combination of cooperation, capable technology and accommodating regulation led to an 80-90% cost savings for trading participants, as well as significant enterprise value for those visionaries. It forced incumbents to innovate and reduce prices, and in some cases consolidate to streamline redundancies and inefficiencies. Chi-X Europe was acquired by BATS (now part of Cboe) in 2011 for $300m, while EMCF was recently acquired by Cboe for EUR 45mm. The founding participants in these platforms saved millions, if not billions in transaction costs by working together, forcing the hand of their service providers and beating them at their own game.
Lessons:
Enduring firms, and especially low cost providers, measure and move continuously; for them, change is constant and evolutionary.
Technology, regulatory, or other disruptions are enabling opportunities.
Help your partners help serve you better. Reimagine and Act with them.
Partnering with best-in-class allows you to drive the industry agenda and make others play your game; it can force change that less motivated incumbents in your value chain must react to.
Successful firms recognize that value-chain partners do not need to be squeezed, but are important business partners who can enable each others’ success.
Serving partners that demand excellence enables scale and agility that can be extended to other partners and customers.
Leadership checklist:
Which firms in your value chain are aligned with, both pain points and opportunities?
What can you do together to reimagine products and services in your space?
What capabilities and value chain relationships do you and potential partners have that can be repurposed to force other value chain links to get aligned to your interests?
Are there partners that can deliver components of your service better than you in your value chain? How can you integrate your capabilities and theirs to improve performance for both you and them?